A reserve analysis is an estimate of an employer’s outstanding liabilities resulting from past retained claims.
The analysis establishes an adequate level of reserves that includes case reserves, unreported claims, and adjustments to case reserves to provide anticipated growth in reserve amounts. In other words, a reserve analysis answers the question, “If a company were to close its doors on a given date, how much money would be required to settle all retained losses occurring prior to that date?”
An employer may question why the sum of the reserves on all open claims is not sufficient to establish the balance sheet liability. However, the sum of the case reserves does not equal outstanding liabilities because this sum excludes the impact of IBNR (incurred but not reported) losses.
The reserve analysis is critical to many organizations. Auditors are more vigilant than ever about verifying the adequacy of loss reserves on an employer’s balance sheet. As a result, a reserve analysis may save significant time and money at audit time. In many cases, reserves not certified by an actuary will not meet your auditor’s standards.
Just as a loss projection will support collateral negotiations for a new program being established, reserve analyses support collateral negotiations for past year’s programs. Collateral requirements should decline over time as losses are paid. However, it is not uncommon to see insurance companies continue to require high levels of collateral for past years. Your actuary should work directly with the employer’s insurance company to establish a mutually agreeable level of collateral.
As part of the report issued by the actuary, a Statement of Actuarial Opinion will sometimes be provided. This is often required of captive insurance companies and self-insured employers. If a company is an SEC registrant, has issued public debt, or is considering going public they should complete a reserve analysis. This provides important assurance to potential investors that the reserve estimate was properly analyzed.
Finally, if an employer is considering acquiring another organization it should have a reserve analysis completed to make a proper valuation of the liability associated with retained losses. Acquiring an organization with understated liabilities would have a detrimental impact on the value of the overall transaction.